PDF Ebook Understanding Business Cycle Synchronization
This paper is concerned with why business cycles are synchronized across countries. Understanding the degree of business cycle synchronization (hereafter “BCS”) is key to understanding a number of phenomena like international policy co-ordination and the transmission of shocks across countries. Perhaps most importantly, a country is more willing to relinquish monetary sovereignty and join a currency union if the other members of the union have business cycles that are highly correlated with its own. This logic was first laid out clearly by Mundell (1961), and has been studied rigorously of late by Alesina and Barro (2002). I am particularly interested in understanding the degree of BCS among East Asian countries, since a high degree of Asian BCS would enhance the case for Asian monetary union (“AMU”).
What drives BCS? Frankel and Rose (1998) first discussed this issue, and focused on international trade linkages. They showed that the extent of international trade between a pair of countries has a theoretically ambiguous effect on their BCS. If trade is mostly driven by factor-proportions and industry-specific shocks play an important role in business cycles, then reduced trade barriers that deepen trade will lower BCS by encouraging specialization and inducing more asynchronous cycles. On the other hand, if trade is mostly intra-industry in nature and aggregate demand shocks are important in business cycles, then enhanced trade can be expected to raise BCS. Empirically, Frankel and Rose found the linkage between trade and BCS to be positive.
In this paper, I build on the work of Frankel and Rose. I begin by reviewing the literature that analyzes the links between trade and BCS. I estimate the size of the effect, and provide some data that allows one to gauge the potential size of the effect in the Asian context.
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PDF Ebook Understanding Business Cycle Synchronization
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